COVID-19 aid to state and local governments is a core component of the proposed $1.9 trillion American Rescue Plan. The bill includes $350 billion of aid to general purpose state and local governments and $175 billion for state and local education, creating a total stimulus package of $525 billion to states.
There are two fundamental problems with Congress’s proposed stimulus package:
First, the amount of COVID-19 aid to states—$525 billion—is too large for the current economic environment. State and local tax revenues have come in surprisingly strong through the pandemic, and federal aid coupled with rainy day funds have already bridged any shortfalls. American Enterprise Institute scholars Stan Veuger and Jeffrey Clemens estimate that the total revenue shortfall for state and local governments relative to pre-pandemic expected growth is only $130 billion through June 2021 in their study State and local budgets are in better shape than expected. The aggregate shortfall has been more than offset by $400 billion in federal aid to the states along with $200 billion of rainy day funds state and local governments had built up prior to the pandemic.
Second, Congress’s aid distribution formula subsidizes policy decisions that were generally made by Democratic leaders and avoided by Republican leaders. Indeed, states that voted for President Biden get significantly more aid per resident ($1,042) than states that voted for President Trump ($901) primarily because the distribution formula favors high unemployment. Additional aid should be dramatically reduced and distributed based on population.
State Policy Network research shows the vast majority of states are afloat on a tidal wave of federal resources. While policymakers have expressed concern that a state and local budget crunch is causing governments to lay off workers, thus inducing economic drag in the states, it appears that state and local government layoffs are steepest in states with heavy economic restrictions, like California (-7.6%) and Michigan (–8.6%), rather than in states that experienced significantly greater revenue shortfalls but remained more open, like Florida (-4.3%) and Texas (-2.3%).
Additional waves of federal COVID-19 aid will undermine fiscal federalism and prudent state budgeting, weakening the economic growth and dynamism that results from healthy competition among the states.
The American Rescue Plan distributes aid to both state and local governments by five different factors:
One way to compare each state’s windfall is to calculate the distribution per resident by state.
The factor that drives the greatest divergence in total distributions is state unemployment (see the map below). The average amount a state receives for its unemployment is $515 per resident, yet because unemployment is so different across states, some states receive much more than average while others receive much less. The average unemployment distribution for states that voted for President Biden is $100 per resident greater than the average in states that voted for President Trump. This distribution occurs because, on average, the states that also voted for President Trump had lower unemployment levels during the months of October, November, and December, which are factored into the distribution’s calculation.
The difference in per-resident distributions breaks out into a significant transfer between the states. For example, states like Georgia and Florida each lose roughly $1.3 billion of the total package due to the unemployment factor, while California gains $5.5 billion and New York gains $2.2 billion. South Carolina loses over a billion while Texas gains over a billion. Indiana loses $900 million and Illinois gains over half a billion. There is no policy justification for these transfers in light of the fact that all of this COVID-19aid is in excess of state need.
Basing COVID-19 relief on state unemployment is a skewed approach because it effectively redistributes aid away from states that did a better job managing their economies and toward states that had greater employment losses due to industry makeup (energy, tourism) or government policy to shut down the economy.
States with high unemployment are already eligible for greater federal in-flows through federal unemployment insurance benefits, PPP loans, and programs like Medicaid. There is no justification to double down on this pattern, especially in light of the fact that the total aid package bears no relation to state revenue losses and is far in excess of any fiscal shortfalls. The general effect, with some exceptions, is to subsidize states that locked down their economies without regard for how their tax revenues have performed.
Any further aid distribution should be limited and sent out based on population. This approach avoids subsidizing any particular state and local political decisions and preserves the healthy interstate competition and dynamism that is so beneficial to our economy.